CHAPTER 6 CorporateLevel Strategy

1
CHAPTER 6Corporate-Level Strategy
2
KNOWLEDGE OBJECTIVES
Studying this chapter should provide you with the
strategic management knowledge needed to

• Define corporate-level strategy and discuss its
  purpose.
• Describe different levels of diversification with
  different corporate-level strategies.
• Explain three primary reasons firms diversify.
• Describe how firms can create value by using a
  related diversification strategy.
• Explain the two ways value can be created with an
  unrelated diversification strategy.
• Discuss the incentives and resources that
  encourage diversification.
• Describe motives that can encourage managers to
  overdiversify a firm.

3
The Role of Diversification

• Diversification strategies play a major role in
  the behavior of large firms.
• Product diversification concerns
• The scope of the industries and markets in which
  the firm competes.
• How managers buy, create and sell different
  businesses to match skills and strengths with
  opportunities presented to the firm.

4
Two Strategy Levels

• Business-level Strategy (Competitive)
• Each business unit in a diversified firm chooses
  a business-level strategy as its means of
  competing in individual product markets.
• Corporate-level Strategy (Companywide)
• Specifies actions taken by the firm to gain a
  competitive advantage by selecting and managing a
  group of different businesses competing in
  several industries and product markets.

5
Corporate-Level Strategy Key Questions

• Corporate-level Strategys Value
• The degree to which the businesses in the
  portfolio are worth more under the management of
  the company than they would be under other
  ownership.
• What businesses should the firm be in?
• How should the corporate office manage the
  group of businesses?

Business Units
6
Levels of Diversification Low Level
Single Business More than 95 of revenue comes
from a single business.

• Dominant Business
• Between 70 and 95 of revenue comes from a
  single business.

7
Levels of Diversification Moderate to High

• Related Constrained
• Less than 70 of revenue comes from a single
  business and all businesses share product,
  technological and distribution linkages.

• Related Linked (mixed related and unrelated)
• Less than 70 of revenue comes from the dominant
  business, and there are only limited links
  between businesses.

8
Levels of Diversification Very High Levels

• Unrelated Diversification
• Less than 70 of revenue comes from the dominant
  business, and there are no common links between
  businesses.

9
FIGURE 6.1 Levels and Types of Diversification
Source Adapted from R. P. Rumelt, 1974,
Strategy, Structure and Economic Performance,
Boston Harvard Business School.
10
Table 6.1 Reasons for Diversification

• Value-Creating Diversification
• Economies of scope (related diversification)
• Sharing activities
• Transferring core competencies
• Market power (related diversification)
• Blocking competitors through multipoint
  competition
• Vertical integration
• Financial economies (unrelated diversification)
• Efficient internal capital allocation
• Business restructuring

• Value-Neutral Diversification
• Antitrust regulation
• Tax laws
• Low performance
• Uncertain future cash flows
• Risk reduction for firm
• Tangible resources
• Intangible resources
• Value-Reducing Diversification
• Diversifying managerial employment risk
• Increasing managerial compensation

11
Value-Creating Strategies of Diversification
Operational and Corporate Relatedness
High
Operational Relatedness Sharing Activities
between Businesses
Low
High
Low
Corporate Relatedness Transferring Skills into
Businesses through Corporate Headquarters
12
FIGURE 6.2 Value-Creating Diversification
Strategies Operational and Corporate Relatedness
13
Related Diversification

• Firm creates value by building upon or extending
• Resources
• Capabilities
• Core competencies
• Economies of Scope
• Cost savings that occur when a firm transfers
  capabilities and competencies developed in one of
  its businesses to another of its businesses.

14
Related Diversification Economies of Scope

• Value is created from economies of scope through
• Operational relatedness in sharing activities
• Corporate relatedness in transferring skills or
  corporate core competencies among units.
• The difference between sharing activities and
  transferring competencies is based on how the
  resources are jointly used to create economies of
  scope.

15
Sharing Activities

• Operational Relatedness
• Created by sharing either a primary activity such
  as inventory delivery systems, or a support
  activity such as purchasing.
• Activity sharing requires sharing strategic
  control over business units.
• Activity sharing may create risk because
  business-unit ties create links between outcomes.

16
Transferring Corporate Competencies

• Corporate Relatedness
• Using complex sets of resources and capabilities
  to link different businesses through managerial
  and technological knowledge, experience, and
  expertise.

17
Corporate Relatedness

• Creates value in two ways
• Eliminates resource duplication in the need to
  allocate resources for a second unit to develop a
  competence that already exists in another unit.
• Provides intangible resources (resource
  intangibility) that are difficult for competitors
  to understand and imitate.
• A transferred intangible resource gives the unit
  receiving it an immediate competitive advantage
  over its rivals.

18
Related Diversification Market Power

• Market power exists when a firm can
• Sell its products above the existing competitive
  level and/or
• Reduce the costs of its primary and support
  activities below the competitive level.

19
Related Diversification Market Power (contd)

• Multipoint Competition
• Two or more diversified firms simultaneously
  compete in the same product areas or geographic
  markets.
• Vertical Integration
• Backward integrationa firm produces its own
  inputs.
• Forward integrationa firm operates its own
  distribution system for delivering its outputs.

20
Related Diversification Complexity

• Simultaneous Operational Relatedness and
  Corporate Relatedness
• Involves managing two sources of knowledge
  simultaneously
• Operational forms of economies of scope
• Corporate forms of economies of scope
• Many such efforts often fail because of
  implementation difficulties.

21
Unrelated Diversification

• Financial Economies
• Are cost savings realized through improved
  allocations of financial resources.
• Based on investments inside or outside the firm
• Create value through two types of financial
  economies
• Efficient internal capital allocations
• Purchase of other corporations and the
  restructuring their assets

22
Unrelated Diversification (contd)

• Efficient Internal Capital Market Allocation
• Corporate office distributes capital to business
  divisions to create value for overall company.
• Corporate office gains access to information
  about those businesses actual and prospective
  performance.
• Conglomerates have a fairly short life cycle
  because financial economies are more easily
  duplicated by competitors than are gains from
  operational and corporate relatedness.

23
Unrelated Diversification Restructuring

• Restructuring creates financial economies
• A firm creates value by buying and selling other
  firms assets in the external market.
• Resource allocation decisions may become complex,
  so success often requires
• Focus on mature, low-technology businesses.
• Focus on businesses not reliant on a client
  orientation.

24
External Incentives to Diversify

• Antitrust laws in 1960s and 1970s discouraged
  mergers that created increased market power
  (vertical or horizontal integration.
• Mergers in the 1960s and 1970s thus tended to be
  unrelated.
• Relaxation of antitrust enforcement results in
  more and larger horizontal mergers.
• Early 2000 antitrust concerns seem to be
  emerging and mergers now more closely scrutinized.

25
External Incentives to Diversify (contd)

• High tax rates on dividends cause a corporate
  shift from dividends to buying and building
  companies in high-performance industries.
• 1986 Tax Reform Act
• Reduced individual ordinary income tax rate from
  50 to 28 percent.
• Treated capital gains as ordinary income.
• Thus created incentive for shareholders to prefer
  dividends to acquisition investments.

26
Internal Incentives to Diversify

• High performance eliminates the need for greater
  diversification.
• Low performance acts as incentive for
  diversification.
• Firms plagued by poor performance often take
  higher risks (diversification is risky).

27
FIGURE 6.3 The Curvilinear Relationship between
Diversification and Performance
28
Internal Incentives to Diversify (contd)

• Diversification may be defensive strategy if
• Product line matures.
• Product line is threatened.
• Firm is small and is in mature or maturing
  industry.

29
Internal Incentives to Diversify (contd)

• Synergy exists when the value created by
  businesses working together exceeds the value
  created by them working independently
• but synergy creates joint interdependence
  between business units.
• A firm may become risk averse and constrain its
  level of activity sharing.
• A firm may reduce level of technological change
  by operating in more certain environments.

30
Resources and Diversification

• A firm must have both
• Incentives to diversify
• The resources required to create value through
  diversificationcash and tangible resources
  (e.g., plant and equipment)
• Value creation is determined more by appropriate
  use of resources than by incentives to diversify.
• Managerial Motives to Diversify
• Managerial risk reduction
• Desire for increased compensation

31
FIGURE 6.4 Summary Model of the Relationship
between Firm Performance and Diversification
Source R. E. Hoskisson M. A. Hitt, 1990,
Antecedents and performance outcomes of
diversification A review and critique of
theoretical perspectives, Journal of Management,
16 498.